Friday, October 28, 2011

A federal judge (SD NY) has questions about the SEC-Citigroup settlement, including why the court should impose a judgment in a case in which the SEC alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing. The judge also asks, given the SEC’s statutory mandate to ensure transparency in the financial marketplace, if there is an overriding public interest in determining whether the SEC’s charges are true, especially when there is no parallel criminal case. More broadly, the court questions how a securities fraud of this nature and magnitude could be the result simply of negligence The court, which is required to ascertain whether the proposed judgment is fair, reasonable, adequate, and in the public interest, has set a November 9 hearing, at which time the parties should be prepared to answer these questions in detail. In addition, the parties are permitted, but not required, to file with the court written answers to these questions in advance of the hearing.

In the enforcement action, the SEC alleged that the principal U.S. broker-dealer subsidiary of the financial institution mislead investors about a $1 billion collateralized debt obligation (CDO) tied to the U.S. housing market in which the entity bet against investors as the housing market showed signs of distress. The CDO defaulted within months, leaving investors with losses while Citigroup made $160 million in fees and trading profits. Without admitting or denying the allegations, the financial institution agreed to settle the SEC’s charges by paying a total of $285 million, which will be returned to investors. (SEC v. Citigroup Global Markets, Inc, SD NY, 11-CIV 7387, Rakoff, J).

The court also wants to know the total loss to the victims as a result of the financial institution’s actions and how this was determined. If, as the SEC’s submission states, the loss was at leastlf $160 million, what was it at most. Also, how was the amount of the proposed judgment determined, asked Judge Rakoff, in particular what calculations went into the determination of the $95 million penalty. The court queries why the penalty in this case is less than one-fifth of the $535 million penalty assessed in SEC v. Goldman Sachs & Co No. 10 Civ. 3229 (S.D.N.Y. July 20 2010).

More broadly, the court asks what reason there is to believe that the proposed penalty will have a meaningful deterrent effect. The SEC’s submission states that the Commission has identified nine factors relevant to the assessment of whether to impose penalties against a corporation and, if so, in what amount. But the submission fails to particularize how the factors were applied in this case. The court asks if the Commission employed these factors in this case and, if so, how should this case be analyzed under each of those nine factors.

The proposed judgment imposes injunctive relief against future violations. The court wants to know what the SEC does to maintain compliance and how many contempt proceedings against large financial entities the Commission has brought in the past decade as a result of violations of prior consent judgments. The court also queries why the penalty in this case is to be paid in large part by the financial institution and its shareholders rather than by the culpable individual offenders acting for the corporation. If the SEC was for the most part unable to identify such alleged offenders, why was this. More granularly, the court asks what specific control weaknesses led to the acts alleged in the complaint and how will the proposed remedial undertakings ensure that those acts do not occur again.